Can You Cash Out On Life Insurance While Alive?

It is possible to access funds from certain life insurance policies while the insured individual is still alive. Many people view life insurance solely as a financial safeguard for beneficiaries after death, but specific policy types offer mechanisms to utilize policy value during one’s lifetime. The primary method for accessing funds in permanent life insurance policies, such as whole life and universal life, involves a component known as “cash value.”

A portion of the premiums paid into these policies contributes to this cash value, which then grows over time, often on a tax-deferred basis. This accumulating cash value can be a source of liquidity, providing financial flexibility for various needs that may arise. Beyond the cash value, other provisions and options exist that allow policyholders to access a portion of their policy’s value or death benefit under specific circumstances, providing additional avenues for financial support while living.

Policy Surrender for Cash Value

Policy surrender involves the complete termination of a life insurance contract by the policyholder, in exchange for its cash surrender value. This action essentially ends the insurance coverage, meaning the death benefit is no longer in effect. The cash surrender value is determined by taking the accumulated cash value of the policy and subtracting any applicable surrender charges, outstanding loans, or unpaid premiums.

Only permanent life insurance policies, such as whole life, universal life, variable life, and indexed universal life, accumulate a cash value and are eligible for surrender. Term life insurance policies provide coverage for a specific period but do not build cash value. The process of surrendering a policy typically requires contacting the insurance company, submitting a formal request form, and providing necessary identification.

Upon successful surrender, the insurer issues a lump-sum payment of the cash surrender value to the policyholder. This payment can be a valuable source of funds for unexpected expenses or other financial needs. However, a significant financial outcome of surrendering a policy is the forfeiture of the death benefit, which means beneficiaries will receive no payout upon the insured’s passing.

Regarding taxation, the amount received from a policy surrender is generally tax-free up to the total premiums paid into the policy, which is considered the cost basis. If the cash surrender value received exceeds the total premiums paid, the difference is considered a taxable gain and is subject to ordinary income tax. Policyholders should consult with a tax professional to understand the specific tax implications for their situation.

Accessing Policy Funds While Keeping Coverage

Policyholders can access funds from their life insurance cash value without terminating the policy, preserving some level of coverage. Two primary methods for achieving this are policy loans and cash value withdrawals, each with distinct mechanics and implications. These options allow for financial flexibility while maintaining the core insurance protection.

Policy Loans

A policy loan allows the policyholder to borrow money directly from the insurance company, using the policy’s accumulated cash value as collateral. The policy remains in force, and the loan amount does not reduce the cash value itself, but rather creates a lien against it. Interest accrues on the outstanding loan balance, and while repayment schedules are flexible, unpaid interest can increase the loan amount over time.

If a policy loan is not repaid, the outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. For example, a $10,000 loan with $500 in accrued interest on a $100,000 policy would result in an $89,500 death benefit payout. Furthermore, if the outstanding loan amount, plus interest, grows to exceed the policy’s cash value, the policy can lapse, leading to the termination of coverage.

Policy loans are generally not considered taxable income, provided the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, and the loan amount exceeds the premiums paid into the policy (cost basis), the difference can become taxable. Insurers typically have a simple process for requesting a policy loan, often requiring a form submission and verification of identity.

Cash Value Withdrawals

Cash value withdrawals are available primarily in flexible premium policies, such as Universal Life insurance. Unlike a loan, a withdrawal directly removes funds from the policy’s cash value, permanently reducing it. This action is not a borrowed amount and, therefore, does not accrue interest or require repayment.

Withdrawing funds directly reduces the policy’s cash value and can subsequently reduce the death benefit. For example, a $5,000 withdrawal from a policy with $20,000 cash value and a $100,000 death benefit would leave $15,000 cash value and potentially reduce the death benefit to $95,000 or lower, depending on policy structure. This reduction in cash value can also impact the policy’s ability to sustain itself, potentially leading to lapse if the remaining cash value becomes insufficient to cover policy charges.

For tax purposes, cash value withdrawals are generally tax-free up to the amount of premiums paid into the policy, which is the cost basis. Any amount withdrawn that exceeds the cost basis is considered a gain and is subject to ordinary income tax. Policyholders typically initiate a withdrawal by contacting their insurer and completing the necessary paperwork to specify the amount and destination of the funds.

Accelerated Benefits and Policy Sale Options

Beyond accessing cash value directly, other methods allow policyholders to receive funds from their life insurance policies while still alive, often under specific circumstances and not always tied to the cash value component. These options include accelerated death benefits and the sale of a policy through viatical or life settlements. Each offers a distinct pathway to liquidity with varying eligibility criteria and financial outcomes.

Accelerated Death Benefits (Living Benefits)

Accelerated death benefits, also known as living benefits, are provisions or riders typically added to a life insurance policy that allow the policyholder to access a portion of their death benefit before passing away. These benefits are triggered by specific qualifying conditions, such as a diagnosis of a terminal illness with a limited life expectancy, chronic illness requiring long-term care, or a critical illness like a heart attack or stroke.

To utilize these benefits, medical certification from a physician is generally required, confirming that the policyholder meets the specified health criteria. The amount received from an accelerated benefit directly reduces the final death benefit that will be paid to beneficiaries upon the insured’s passing. For instance, if a policyholder with a $200,000 death benefit receives $50,000 in accelerated benefits, the remaining death benefit would be $150,000.

Generally, accelerated death benefits received for qualifying conditions are considered tax-free under federal law, provided certain conditions regarding the severity of the illness are met. This tax-exempt status can provide significant financial relief for individuals facing substantial medical or long-term care expenses. The process involves submitting an application to the insurer, often with supporting medical documentation.

Viatical and Life Settlements

Viatical and life settlements involve selling a life insurance policy to a third-party company for a lump-sum payment. This payment is typically more than the policy’s cash surrender value but less than the full death benefit. The third-party buyer then takes over premium payments and becomes the new beneficiary, receiving the full death benefit when the insured passes away.

A viatical settlement is specifically for individuals who are terminally or chronically ill, often with a life expectancy of 24 months or less. A life settlement, in contrast, is for individuals who are typically older (e.g., age 65 or older) or have a shortened life expectancy due to health conditions, but are not necessarily terminally ill. Eligibility criteria often include the policy type (permanent policies are preferred) and a minimum policy face amount.

The process for a settlement involves obtaining offers from various settlement providers, providing medical records and policy information for evaluation, and, upon acceptance of an offer, transferring policy ownership. A significant impact of a settlement is that the original beneficiaries receive no death benefit, as the policy is sold to a new owner.

From a tax perspective, the amount received from a viatical or life settlement can have tax implications. Generally, for viatical settlements, the proceeds may be tax-free if the insured is certified as terminally or chronically ill, similar to accelerated death benefits. For life settlements, any amount received above the policy’s cost basis (premiums paid) is typically taxable as ordinary income. Furthermore, if the amount received exceeds the policy’s cash surrender value, that portion may be treated as a capital gain.